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How Does Reverse Mortgage Work

    A reverse mortgage is a loan type that allows homeowners 62 years old or older, usually those already paying down a mortgage, to borrow part of the equity in the house as tax-free income. This allows homeowners age 62 or older to turn part of their homes equity into cash, without making a monthly mortgage payment. A financial tool that allows seniors to access their home equity and age in place, reverse mortgages can liberate cash during retirement, and, in some cases, remove the monthly mortgage payments.

    While originating reverse mortgages may be the easiest to obtain and quickest to finance, they are also known to attract unscrupulous professionals who use reverse mortgages as a way to con unsuspecting seniors out of the equity of their properties. Reverse mortgages can be an asset to homeowners looking for extra income in retirement years, with many using the funds to supplement Social Security or other income, cover medical expenses, pay for home-based assistance, and make home improvements, says Jackie Boies.

    Interest accrues each month on a reverse mortgage, and you still have to have enough income to keep paying property taxes, homeowners insurance and maintaining your home. If you fail to pay property taxes, keep homeowners insurance, or keep the house in good repair, your lender may demand that you pay back your loan. For example, if you fail to pay your property taxes or homeowners insurance, you default on a presumed default on your Set-Aside Account (see below), fail to keep the house in reasonable condition, or violate any of the other mortgage requirements, the lender may foreclose.

    Federal regulations require lenders to structure transactions such that the amount lent does not exceed the home value, and if the total amount of the loan actually becomes larger than the value of the home, either the borrower or the borrowers estate is not responsible for paying the difference. If the home declines in value, a homeowner or homeowners estate is not required to pay the difference if a reverse mortgage loan is larger than the homes value.

    At this point, the borrower (or his heirs) may repay the majority of reverse mortgage loans and keep the house, or they may sell the house and use the proceeds to pay off the loan, with the seller keeping whatever proceeds are left over when the loan is paid off. When the loan is paid off, any remaining equity is passed down to the heirs, or as your will or trust directs. The loan and interest are paid off only if you sell the house, permanently move out, or pass away.

    Homeowners who choose this type of mortgage have no monthly payments, nor are they required to sell the house (in other words, they are free to keep living there), but the loan is required to be paid off when the borrower dies, permanently moves out, or sells the house. The homeowner may borrow money from a lender based on the value of their home, and get that money either as a line of credit or a monthly payment. A reverse mortgage is paid off when the borrower dies, lives out of their house for over 12 months, sells the property, or stops paying taxes and homeowners insurance.

    In reverse mortgages, the individual already owns a house, they take out a claim on the home, getting a loan from the lender which they might not necessarily ever repay. With a reverse mortgage, a homeowner who owns his home outright–or, at the very least, has significant equity to draw upon–can draw on part of his home equity, with no obligation to pay back until they move out of the house. With a traditional mortgage, an individual takes out a loan to purchase the house, and then pays back the lender over time.

    When you have a traditional mortgage, you are paying a lender each month in order to purchase a house over time. With a conventional mortgage, you are given money up front to purchase a house, and must start paying back that borrowed money immediately each month over a period of years. If your lender allowed you to borrow against the full value of your house, then your mortgage would become underwater almost immediately.

    If you owed $150,000 on the loan, and sold your house for $200,000, you would first pay the loan down, and then hold onto the remaining $50,000. Depending on how much you owe, you keep whatever proceeds from the remaining sale once you have paid the loan back.

    When using the governments backed reverse mortgage program, homeowners are limited to borrowing up to their homes assessed value or the FHAs maximum loan amount ($765,600). A reverse home equity mortgage allows homeowners to convert equity that has accrued in their homes to cash. Many homeowners want to have access to their equity, but they are unwilling to sell and relocate, or may not earn enough to qualify for a second mortgage, like a traditional home equity loan or a home equity line of credit.

    Warning signs Cut the signs Some lenders have distorted the understanding of reverse mortgages and failed to explain their clients the fine print A contractor trying to convince a homeowner that the best way to cover expensive home repairs is by taking out a reverse mortgage Some companies market aggressively to older adults, who may lack financial knowledge to understand the implications of taking on a new loan such as this One few homeowners are duped into investing loan proceeds in risky stocks or schemes such as house flipping, or to hand the money to a third party. Relatives, caregivers, and financial advisers have also taken advantage of seniors by using power of attorney to reverse mortgage a home, then stealing the proceeds, or by convincing them to buy a financial product, such as an annuity or whole life insurance, that the senior can only afford by getting a reverse mortgage.

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